OPEN ECONOMY I: THE MUNDELL–FLEMING MODEL
317
increases, the
LM
curve shifts to the right in the direction of the arrows in
the diagram. Eventually, the
LM
curve settles at point N where the deficit on
the current account at point R is financed by a capital inflow that is induced
by a relatively high domestic interest rate. Hence, a
FISCAL
EXPANSION
in a fixed
exchange rate regime results in
1.
a rise in the interest rate and income and a surplus in the BP in the short
run
2.
a further increase in income and a decline in the interest rate from its short-
run level, with no change in the overall BP and accompanied by a current ...
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